Premium Essay

Finance and Accounting Risk and Return

In: Business and Management

Submitted By benbaurmann
Words 817
Pages 4
Report Task 1 Group 1

To be able to understand and cope with task one some basic concepts we have already learned in the previous finance course must be refreshed and explained once again.

There are two types of risk called the firm-specific/idiosyncratic risk and the systematic/market risk. The distinction between those is that firm-specific risk only affects the company itself and can be diversified. For example, the top manager leaves the company because he has been offering a better job. This risk can be diversified by hiring someone else and does not affect the whole economy.
The market risk affects all stocks simultaneously and cannot be diversified. An example would be an earthquake. Since diversification cannot eliminate market risk the risk premium only depends on it.

Another concept is the Capital Asset Pricing Model. There are three main assumptions that underlie the CAPM and allow us to identify the efficient portfolio of risky assets. 1. Securities are traded at competitive market prices 2. Investors choose efficient portfolios 3. Investors have homogenous expectations
When these assumptions hold, the market portfolio and the efficient portfolio coincide. The efficient portfolio is the point where the capital market line, which is the line from the risk-free investment through the market portfolio, is tangent to the efficient frontier and represents the highest expected return available for any level of volatility. If we go up the efficient frontier investors can obtain portfolios by borrowing or lending at the risk-free rate.
The security market line (SML) shows the expected return for each security as a function of its beta. Beta measures risk. Under the CAPM assumptions all stocks and portfolios should lie on the SML, which implies that the market portfolio is efficient.

The second part of the task is an exercise which will...

Similar Documents

Premium Essay

Calculating the Beta of Coca Cola

...Required Rate Of Return For Coca-Cola John C. Gardner, University of New Orleans, USA Carl B. McGowan, Jr., Norfolk State University, USA Susan E. Moeller, Eastern Michigan University, USA ABSTRACT In this paper, we demonstrate how to compute the required rate of return for Coca-Cola using modern portfolio theory with data downloaded from the internet. We demonstrate how to calculate monthly returns for the index and Coca-Cola and how to use the returns to compute the beta coefficient and the required rate of return using the downloaded data. We show how to validate the data for the market index and the company and how to compute the returns using the dividend and stock split adjusted prices. We demonstrate how to graph the characteristic line for Coca-Cola and use the graph to check that the regression was run correctly. We use Coca-Cola and the S&P 500 Index in this paper, but any company listed on Yahoo! Finance can be used as the example. This paper can be used as the basis of a lecture on intermediate corporate finance or investments to demonstrate the process using a real company. Keywords: beta; characteristic line; required rate of return; Coca-Cola; teaching note INTRODUCTION M arkowitz1 (1952) began modern portfolio theory (MPT) which can be used to explain the relationship between risk and return for assets, particularly stocks. Stock of companies that have higher rates of return have higher levels of risk. In order to achieve a lower level of risk, an......

Words: 3716 - Pages: 15

Premium Essay

Definitions of Finance

...Definitions for Finance FIN/370 February 24, 2014 Finance Definitions Finance – Is the study of people and business invest and raise capital to fund them. It is the study of how it addresses the following: 1. What long-term investments should the firm undertake?This area of finance is generally referred to as capital budgeting. 0 2. How should the firm raise money to fund these investments?The firm’s funding choices are generally referred to as capital structure decisions. 3. How can the firm best manage its cash flows as they arise in its day-to-day operations?This area of finance is generally referred to as working capital management. The principle of finance is the following: Principle 1: Money Has a Time Value A dollar received today is worth more than a dollar received in the future. Conversely, a dollar received in the future is worth less than a dollar received today. Principle 2: There Is a Risk-Return Tradeoff We won’t take on additional risk unless we expect to be compensated with additional return. Principle 3: Cash Flows Are the Source of Value Cash flow measures the amount of cash that can actually be......

Words: 1558 - Pages: 7

Premium Essay

Wongxiaoming

...to valuation: minimizes ad hockery – Built on theoretical and empirical findings from scientific research I ‘_ Marries fundamental analysis and financial statement analysis – Exploits accounting as a system for measuring value added – Exposes good (and “bad”) accounting from a valuation perspective L Financial Statement Analysis and Security Valuation • • • Integrates financial statement analysis with corporate finance Focuses on technologies that can be used in practice – Based on real world examples Adopts activist point of view to investing – The market may be inefficient 0-1 What Will You Learn from the Course Part I Financial statements and valuation Ch. 1-7 • How intrinsic values are calculated • What determines a firm’s value • How businesses are analyzed to assess the value they create • How financial analysis is developed for strategy and planning • The role of financial statements in determining firms’ values • How to pull apart the financial statements to get at the relevant information • How ratio analysis is employed in valuation • How growth is analyzed and valued • How to calculate the P/E and P/B ratio and what they should be • The value of operations • How to make forecasts and develop valuations • How to assess the quality of the accounting 0-2 _c I- By the end of the course, students should be able to develop earnings forecasts and then use the forecasts to value equity and form investment recommendations, much the same......

Words: 2057 - Pages: 9

Premium Essay

Doc Introduction to Accounting

...contains Contains pages Executive summary Introduction……………………………………………………………………………………………….3 1. The different types of business units: a) Sole proprietorship………………………………………………………………………..4 b) Partnership……………………………………………………………………………………5 c) Private limited company………………………………………………………………..6 d) Public limited company………………………………………………………………….6 2. Difference between ,Financial accounting and Management accounting: a) Nature of report…………………………………………………………………………….6 b) Details level……………………………………………………………………………………7 c) Regulations…………………………………………………………………………………….7 d) Interval report………………………………………………………………………………..7 e) Time orientation…………………………………………………………………………….8 f) Range and information quality………………………………………………………..8 3. Sources of finances 3.1 Internal and external sources…………………………………………………………8 3.2 Short and long term finance…………………………………………………………..8 3.3 Debt and equity…………………………………………………………………………….9 4. Recommendation………………………………………………………………………………….9 Conclusion………………………………………………………………………………………………10 References………………………………………………………………………………………………11 14 November 2014 To Mr and Mrs Swanson From: Felicia masela Subject: Starting-up a new chocolate and biscuits company. Dear sir / Madam Swanson, Executive summary Starting-up a business required choices existing that......

Words: 2521 - Pages: 11

Premium Essay

Valuing Coca Cola

...acquisition and allocation of funds. The objective of corporate financial management is to maximize the value of the firm. Solomon (1963, page 22, Chapter II) argues that wealth maximization should be the goal of corporate financial management because this criterion maximizes the wealth of the owners of corporations and maximizes the wealth of a society by maximizing economic output. The value of the firm is measured by the market capitalization of the firm. The market capitalization for the firm is calculated by multiplying the total number of shares outstanding times the market price per share. The value of the firm is determined by the risk and return characteristics of the firm. Firms that wish to achieve a higher rate of return must assume a higher level of risk. Firms that wish to have a lower level of risk must accept a lower rate of return. A...

Words: 4461 - Pages: 18

Premium Essay

Accounting

...ownership of asset and the ownership of the asset will return back to Monash Ltd at the end of the lease term. (NO) b) Monash Ltd purchased the bulldozer just before the inception of the lease and Ballarat Ltd does not intend to purchase the bulldozer thus there would be no bargain purchase option. (NO) c) Length of lease 5 years divided 8 years of economic life of the bulldozer which will equal to 62.5%. Thus, based on the professional practice, an asset would classify as finance lease only when it greater than 75% of its economic life of the asset. (NO) d) The present value of the asset and the MLP of Ballarat Ltd lease payment to Monash Ltd is $8000x3.8897 (annuity factor) = $31118. While, the guaranteed residual value of the bulldozer is 50% of $7200 which should also include in MLP, $3600x0.6499 = $4679. So, the total PV of MLP is $35797, which is more than the PV of the bulldozer at the acquisition of the lease $34797. Thus, PV is substantially all of the fair value of the leased asset. e) There are not clear that the leased assets are of such a specialised nature that only the lessee can use them without major modification. AASB 117, par 11: a) The lease can be cancel, but there will be a penalty of 50% of the total lease payment Ballarat Ltd has to pay to Monash Ltd. Thus, the losses associated with the cancellation are borne by the lessee Ballarat Ltd and this show that the lessee takes on the risks and rewards of...

Words: 2817 - Pages: 12

Premium Essay

Curriculum Source References

...Hedge Funds: Risk, Return, and Incentives.” Journal of Finance. Vol. 54, No. 3: 833–874. ACLI Survey. 2003. The American Council of Life Insurers. Agarwal, Vikas and Narayan Naik. 2000. “Performance Evaluation of Hedge Funds with OptionBased and Buy-and-Hold Strategies.” Working Paper, London Business School. Ali, Paul Usman and Martin Gold. 2002. “An Appraisal of Socially Responsible Investments and Implications for Trustees and Other Investment Fiduciaries.” Working Paper, University of Melbourne. Almgren, Robert and Neil Chriss. 2000/2001. “Optimal Execution of Portfolio Transactions.” Journal of Risk. Vol. 3: 5–39. Altman, Edward I. 1968. “Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy.” Journal of Finance. Vol. 23: 589–699. Altman, Edward I. and Vellore M. Kishore. 1996. “Almost Everything You Wanted to Know about Recoveries on Defaulted Bonds.” Financial Analysts Journal. Vol. 52, No. 6: 57−63. Altman, Edward I., R. Haldeman, and P. Narayanan. 1977. “Zeta Analysis: A New Model to Identify Bankruptcy Risk of Corporations.” Journal of Banking and Finance. Vol. 1: 29−54. Ambachtsheer, Keith, Ronald Capelle, and Tom Scheibelhut. 1998. “Improving Pension Fund Performance.” Financial Analysts Journal. Vol. 54, No. 6: 15–21. Ambachtsheer, Keith. 1986. Pension Funds and the Bottom Line: Managing the Corporate Pension Fund as a Financial Business. Homewood, IL: Dow Jones-Irwin. American Accounting Association Financial Accounting Standards......

Words: 12603 - Pages: 51

Premium Essay

Investor Buyer Sentiment

...major foundation of behavioral finance: | | |Limited arbitrage | | |Investor sentiment | |Shleifer (2000) |Investor sentiment is mainly driven by two phenomena: | | |The tendency of people to view events as representative of some specific | | |class and ignore the laws of probability in the process | | |And conservatism. | |Lee, Shleifer & Thaler (1991) |CEFD suggest that as the discount increase, retail investor sentiment | | |decrease. | |Barber, Odean and Zhu(2006) |Stocks heavily bought by individual investors one week earn stronger | | |returns in the subsequent week. ......

Words: 3861 - Pages: 16

Premium Essay

Accounting Finance Department Hierarchy

...College of Commerce Financial Accounting ACCT3013 Prof. Hafiz Imtiaz Reg. No. 2035 – Minahil Raza Reg. No. 2030 - Ahmad Waqas Reg. No. 2001 - Syed Faizan Jaffri December 15, 2013 Difference between Accounting & Finance Accounting is an art of recording, classifying and summarizing the transaction in a significant manner, whereas finance is the management of money and other valuables, which can easily be converted into cash. Functions of Finance Department of an Organization * Preparation of Budget Plans It is duty of finance department of company to make the budget before actual providing money to any department. It helps to fulfill each department with minimum cost. * Financial Management In this function finance department gets money from capital market at very low risk and cost. Finance department analyzes all the resources of funds and create a good financial structure of company. In this structure, finance department analyze whether it will decrease the overall cost of capital on Average basis or not.  * Management of Investments of Company After making financial structure, finance department invests debenture holders and shareholders money in best projects for getting highest return on investment. For this finance department takes investment decision. These investment decisions can be taken with the help of capital budgeting and investment analysis techniques.  * Management of Financial Risks Financial department takes......

Words: 1304 - Pages: 6

Premium Essay

Studentcorner

...1. Be able to analyze the financial data Finance: It is the study of the management of the funds. Key domains of financing are: * Business finance. * Private finance (personal loan). * The public finance. Finance deals with the savings of money and frequently deals with the lending matters. The field of the finance offers with the time concepts, money, the risk and how they are secured. It takes care of how money used in budgeting. The one of the main source of the financing is through individuals and organizations that deposit or invest money. The banks issue money to other natural or lawful people for the expenditure and charge interest. Why the businesses need the financing Commencement of a new business A business needs a financing to buy the equipment, machinery and to spend on personnel. Money will be so necessary to cover the routine functioning expenses. Finance for the expansions of production capacity As growing a business, it has to be able to produce a newer technology and the machinery and to reduce costs and to live a day competitors. To develop product and to market the products A business has to spend money for the development and marketing of products. To enter in newly market Whenever ventures grow, they sell its products on new business markets. It can be new geographic areas to sell or types of customers. That costs money in a way of investigation and of marketing, for example advertising campaigns and the creation of...

Words: 2796 - Pages: 12

Premium Essay

Financing Lease

...A finance lease or capital lease is a type of lease. It is a commercial arrangement where: the lessee (customer or borrower) will select an asset (equipment, vehicle, software); the lessor (finance company) will purchase that asset; the lessee will have use of that asset during the lease; the lessee will pay a series of rentals or installments for the use of that asset; the lessor will recover a large part or all of the cost of the asset plus earn interest from the rentals paid by the lessee; the lessee has the option to acquire ownership of the asset (e.g. paying the last rental, or bargain option purchase price); The finance company is the legal owner of the asset during duration of the lease. However the lessee has control over the asset providing them the benefits and risks of (economic) ownership.[1] Treatment in India : Finance lease is the one in which risk and rewards incidental to the ownership of the leased asset is transferred to lesee but not the actual ownershipship. Thus in case of finance lease lease we can say that notional ownership is passed to the lesee. Treatment in the United States Under US accounting standards, a finance (capital) lease is a lease which meets at least one of the following criteria: ownership of the asset is transferred to the lessee at the end of the lease term; the lease contains a bargain purchase option to buy the equipment at less than fair market value; the lease term equals or exceeds 75% of the asset's estimated......

Words: 1191 - Pages: 5

Premium Essay

Danshui

...The Australasian Accounting Business & Finance Journal, February 2007 Gaffikin: Accounting Research and Theory: the age of neo-empiricism. Vol. 1, No.1.pp. 1-19. Accounting Research and Theory: The age of neo-empiricism Michael Gaffikin, School of Accounting & Finance, University of Wollongong ABSTRACT The theorising in accounting prior to 1970 was rejected as not providing sufficiently general theories. Informed by theories in economics and finance (and other disciplines such as psychology) and with the aid of computers, attempts to theorise accounting took a new direction. Large data collection and analysis emphasized a purportedly more systematic empirical approach to developing theory. Key words: accounting; neo-empiricism; capital markets research; behavioural finance; efficient markets hypothesis; positive accounting theory INTRODUCTION Around 1970 there was a dramatic change in the approach to accounting research. Several reasons have been suggested for this change in methodological direction by those reviewing the development of accounting thought. To many, a major distinction is a change in direction away from attempts to prescribe a theory of accounting to developing theory from a description of extant practices. To advocates of the latter, previous attempts to develop a theory of accounting were futile as there could never be agreement over many of the inputs into a theory such as the postulates, principles but most specifically the assumptions. Although......

Words: 10399 - Pages: 42

Free Essay

Behavior of Finance

...Behavioural Finance Martin Sewell University of Cambridge February 2007 (revised April 2010) Abstract An introduction to behavioural finance, including a review of the major works and a summary of important heuristics. 1 Introduction Behavioural finance is the study of the influence of psychology on the behaviour of financial practitioners and the subsequent effect on markets. Behavioural finance is of interest because it helps explain why and how markets might be inefficient. For more information on behavioural finance, see Sewell (2001). 2 History Back in 1896, Gustave le Bon wrote The Crowd: A Study of the Popular Mind, one of the greatest and most influential books of social psychology ever written (le Bon 1896). Selden (1912) wrote Psychology of the Stock Market. He based the book ‘upon the belief that the movements of prices on the exchanges are dependent to a very considerable degree on the mental attitude of the investing and trading public’. In 1956 the US psychologist Leon Festinger introduced a new concept in social psychology: the theory of cognitive dissonance (Festinger, Riecken and Schachter 1956). When two simultaneously held cognitions are inconsistent, this will produce a state of cognitive dissonance. Because the experience of dissonance is unpleasant, the person will strive to reduce it by changing their beliefs. Pratt (1964) considers utility functions, risk aversion and also risks considered as a proportion of total assets. Tversky and......

Words: 4442 - Pages: 18

Premium Essay

Marketing Mix

...Question-1: What is finance? Ans: Finance is the life blood of every corporation. In the era of modern trade and commerce, business firm have to decide from where they will raise fund, where they will invest and how much of the profit will be distributed among the shareholders. “Finance” Came from Latin word “finis” means “dealing with the money”.finace is called the art and science of managing money. At the micro level, finance is the study of financial planning, asset management and fund raising for business and financial institutions. At the macro level, finance is the study of financial institution and financial markets and how they operate within the financial systems in both the domestic and global economics. Scholar’s view: “Finance consists of providing and utilizing the money, capital rights, credit and funds of any kind which are employed in the operation of an enterprise.” _George R Terry “Finance is concerned with the process, institutionsmarkets and instruments involved in the transfer of money among and between individuals, business and governments”. _Lawrence J Gitman From the above discussion, it can be said that finance is the process of financial planning, identification of sources of fund raising, investment of fund, protection of fund,......

Words: 7921 - Pages: 32

Premium Essay

Presentation of Fa

...is the crystal of our group members, everyone made contribution on it. Our presentation will be divided into two parts. In the first part, I would like to show couples of “take-aways” in this module. Then, for the second part, Lady Wang Dan will make explanation to the questions, of course, only few typical questions will be explained in details, rest of them will be reviewed quickly. 1. Accounting and finance Actually the accounting provides information to the shareholders, creditor, government who are outside of the company, and also provide information to all levels of manager who direct and control its operation. At very bottom line, the finance is all about allocation of assets or money. But how to make decision? So the potential investor needs information to support their decision. So they come to see the accounting statements. It is a real reflection of the condition of one company if there is no fake information. After the information is got from accounting, they could allocate money. So at very bottom line we can summarize that the accounting is a tool to support the finance to make money. 2. Equity premium puzzle Actually this terminology really puzzled me when I looked at it for the first time. A lot of complicated formulas are involved in it. Unfortunately I am not good at mathematics, but fortunately I will talk about formulas because I was always failed in my math exams. What can I do? Use a simple example to show my understanding. Most of us here......

Words: 670 - Pages: 3